Annual Report pursuant to Section 15(d) of the Securities and Exchange Act of 1934 (fee required) for the fiscal year ended December 31, 2001. Commission File No. 0-13666

State of other jurisdiction of incorporation or organization:   Maine
IRS Employer Identification Number: 01-0393663
Address: PO Box 400, 82 Main Street, Bar Harbor, ME Zip Code: 04609-0400
Registrant’s telephone number, including area code: (207) 288-3314

Securities registered pursuant to Section 12(g) of the Act:
Title of Class: Common Stock. Par Value $2.00 per share

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(D) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes XX

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definite proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this form 10-K.

Based on the closing price of the common stock of the registrant, the aggregate market value of the voting stock held by non-affiliates of the registrant, as of March 19, 2002 is:
Common Stock, $2.00 par value $55,506,942

The number of voting shares outstanding of each of the registrant’s classes of common stock, as of March 19, 2002 is:
Common Stock 3,246,020

Documents incorporated by Reference:
Proxy Statement for 2002 annual meeting pursuant to Regulation 14A of the General Rules and Regulations of the Commission and filed with the Commission on March 26, 2002, is incorporated by reference into Part III of this report.

INDEX

ITEM 1. BUSINESS

ORGANIZATION

Bar Harbor Bankshares ("the Company") was incorporated January 19, 1984. As of March 19, 2002, the Company’s securities consisted of one class of common stock ("the Common Stock"), par value of $2.00 per share, of which there are 3,246,020 shares outstanding held of record by approximately 1,088 shareholders. The Company has two primary, wholly-owned operating subsidiaries: Bar Harbor Banking and Trust Company ("the Bank"), a community bank which offers a wide range of deposit, loan, and related banking products; and BTI Financial Group ("BTI"), a financial services holding company that offers brokerage, trust, and investment management services.

The Company is a bank holding company ("BHC") registered under the Bank Holding Company Act of 1956, as amended (the "BHC Act"), and is subject to supervision, regulation and examination by the Board of Governors of the Federal Reserve System (the "FRB"). The Company is also a Maine Financial Institution Holding Company for the purposes of the laws of the State of Maine, and as such is subject to the jurisdiction of the Superintendent (the "Superintendent") of the Maine Bureau of Financial Institutions ("BFI").

BANK

The Bank has ten offices in coastal Maine, including its principal office located at 82 Main Street, Bar Harbor, as well as offices in Hancock County and adjacent Washington County, which represent the Bank’s principal market areas. The Hancock County offices, in addition to Bar Harbor, are located in Northeast Harbor, Southwest Harbor, Blue Hill, Deer Isle, Ellsworth, and Winter Harbor. The Washington County offices are located in Milbridge, Machias, and Lubec. The Company delivers its operations and technology services from its operations center located on Avery Lane in Ellsworth, Maine.

The Bank is a retail bank serving individual and corporate customers, retail establishments, seasonal lodging, campgrounds and restaurants. As a coastal bank, it serves the lobstering, fishing, and aquaculture industries. It also serves Maine’s wild blueberry industry through its Washington County offices. It operates in a competitive market that includes other community banks, savings institutions, and credit unions, and branch offices of statewide and interstate bank holding companies located in the Bank’s market area. The Bank continues to be one of the larger independent commercial banks in the State of Maine.

The Bank has a broad deposit base and loss of any one depositor or closely aligned group of depositors would not have a materially adverse effect on its business. Approximately 84% of the Bank’s deposits are in interest bearing accounts. The Bank has paid, and anticipates that it will continue to pay, competitive interest rates on certificates of deposit, IRAs, NOW and money market accounts and does not anticipate any material loss of these deposits. Deposit growth continues to be a challenge in the communities served by the Bank. From 1994 through 2001, the nation’s deposits grew at an annual rate of 4.61%, while Maine’s deposits grew at 2.72%.

The Bank provides the normal banking services offered by a commercial bank, including checking accounts, NOW accounts, all forms of savings and time deposit accounts, individual retirement accounts, safe deposit boxes, collections, travelers checks, night depository services, internet banking services, direct deposit payroll services, automated teller services, credit cards, personal money orders, bank-by-mail and club accounts, drive-up facilities at all offices, and TeleDirect, an interactive voice response system through which customers can get product information, check balances and activity on their accounts as well as perform transfers between their own accounts. In February 2001, the Bank began offering Internet banking services through its dedicated website at www.bhbt.com. The Bank also has arrangements with other institutions for the provision of certain services, which it does not provide directly, such as computerized payroll services. Automated Teller Machines (ATMs) are located in each of the ten branch locations in addition to two machines in non-Bank locations. These ATMs access major networks for use of the Bank’s cards throughout the United States, including the Plus and NYCE systems as well as the major credit card networks.

The Bank offers a comprehensive array of lending services, including consumer credit in the form of installment loans, overdraft protection (stand-by credit), VISA credit card accounts, student loans, residential mortgage loans, and home equity loans. It offers business loans to individuals, partnerships, corporations, and other business entities for capital construction, the purchase of real estate, working capital, and a broad range of other business purposes. Business loans are provided primarily to organizations and individuals in the tourist, hospitality, health care, blueberry, shipbuilding, fishing, and aquaculture industries as well as to other small to mid-size businesses associated with small coastal communities. Certain larger loans, which exceed the Bank’s lending limits, are written on a participation basis with correspondent banks, with the Bank retaining only such portions of those loans that are within its lending limits. The Bank’s policy for lending limits is up to 20% of its equity to any borrower provided that the loans are secured, and approved by the Directors’ Loan Committee. This committee is chaired by a member of the Bank’s Board of Directors, Bernard K. Cough, and includes members of the Bank’s management and Board of Directors.

BTI

BTI Financial Group is a wholly owned subsidiary of the Company. It was incorporated on August 16, 1999, as the holding company for three operating subsidiaries: Bar Harbor Trust Services ("Trust"), a newly formed Maine corporation that performs the trust functions formerly performed by the Trust Department of the Bank; Block Capital Management ("Block"), an SEC registered investment advisor; and Dirigo Investments, Inc. ("Dirigo"), an SEC registered broker-dealer.

Trust operates as a Maine chartered, non-depository trust company offering revocable, irrevocable, charitable remainder and testamentary trust management, and estate planning and management services such as probate, estate settlement, and tax return preparation. At December 31, 2001, Trust had 1,300 accounts.

Block, an SEC registered investment advisor, provides discretionary and non-discretionary investment advisory services for corporate and individual investment portfolios, personal trusts, individual and corporate retirement funds, and endowments for not-for-profit organizations. At December 31, 2001, Block had $239 million under management, primarily for clients of Trust.

Dirigo was purchased by BTI in January 2000. It is a registered broker/dealer and serves the brokerage needs principally of individuals from first-time purchasers to sophisticated investors. It also offers a line of life insurance and annuity products. A third party processor provides Dirigo’s support and clearing services.

BTI’s central offices are located in a recently renovated, 22,000-square-foot office facility located at 135 High Street, Ellsworth, Maine. Dirigo, Trust, and Block maintain their principal offices at the Ellsworth facility and maintain additional offices at One Cumberland Place, Bangor, Maine. BTI also maintains offices in the headquarters building of the Bank in Bar Harbor, Maine.

The subsidiaries of BTI each separately face significant competition for their services from local banks and nonbanks, which may now or in the future offer a similar range of services, as well as from a number of brokerage firms and investment advisors with offices in the Bank’s market area. In addition, most of these services are widely available to the Bank’s customers by telephone and over the Internet through firms located outside the Bank’s market area.

SUPERVISION AND REGULATION

The business in which the Company and its subsidiaries are engaged is subject to extensive supervision, regulation, and examination by various federal and state bank regulatory agencies, including the FRB, the FDIC, and the Superintendent, as well as other governmental agencies in the states in which the Company and its subsidiaries operate. The supervision, regulation, and examination to which the Company and its subsidiaries are subject are intended primarily to protect depositors and other customers or are aimed at carrying out broad public policy goals, and not necessarily for the protection of the shareholders.

Some of the more significant statutory and regulatory provisions applicable to banks and BHCs to which the Company and its subsidiaries are subject are described more fully below, together with certain statutory and regulatory matters concerning the Company and its subsidiaries. The description of these statutory and regulatory provisions does not purport to be complete and it qualified in its entirety by reference to the particular statutory or regulatory provision. Any change in applicable law or regulation may have a material effect on the Company’s business and operations, as well as those of its subsidiaries. The Company’s shareholders generally are not subject to these statutory and regulatory provisions.

BHCs – Activities and Other Limitations. As a registered BHC and a Maine financial institution holding company, the Company is subject to regulation under the BHC Act and Maine law and to examination and supervision by the FRB and the Superintendent, and is required to file reports with, and provide additional information requested by, the FRB and the Superintendent. The FRB has the authority to issue orders to BHCs to cease and desist from unsound banking practices and violations of conditions imposed by, or violations of agreements with, the FRB. The FRB is also empowered to assess civil money penalties against companies or individuals that violate the BHC Act or orders or regulations thereunder, to order termination of non-banking activities of non-banking subsidiaries of BHCs, and to order termination of ownership and control of a non-banking subsidiary of a BHC.

Various other laws and regulations, including Sections 23A and 23B of the Federal Reserve Act, as amended (the "FRA"), generally limit borrowings, extensions of credit, and certain other transactions between the Company and its non-bank subsidiaries and its affiliate insured depository institutions. Section 23A of the FRA also generally requires that an insured depository institution’s loans to non-bank affiliates be secured in appropriate amounts, and Section 23B of the FRA generally requires that transactions between an insured depository institution and its non-bank affiliates be on market terms. These laws and regulations also limit BHCs and their subsidiaries from engaging in certain tying arrangements in connection with any extension of credit, sale or lease of property, or furnishing of services.

The BHC Act prohibits a BHC from acquiring substantially all the assets of a bank or acquiring direct or indirect ownership or control of more than 5% of the voting shares of any bank, or increasing such ownership or control of any bank, or merging or consolidating with any BHC without prior FRB approval. Unless a BHC becomes a financial holding company" (an "FHC") under the Gramm-Leach-Bliley Act ("GLBA"), as discussed below, the BHC Act also prohibits a BHC from acquiring a direct or indirect interest in or control of more than 5% of the voting shares of any company which is not a bank or BHC and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiary banks, except that it may engage in and may own shares of companies engaged in certain activities the FRB determined to be so closely related to banking or managing and controlling banks as to be a proper incident thereto. In addition, Maine law requires approval by the Superintendent prior to acquisition of more than 5% of the voting shares of a Maine financial institution or any financial institution holding company which controls a Maine financial institution. The Superintendent also must approve acquisition by a Maine financial institution holding company of more than 5% of a financial institution or financial institution holding company domiciled outside of the State of Maine.

The GLBA established a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers by revising and expanding the BHC Act framework to permit BHCs that qualify and elect to be treated as FHCs to engage in a range of financial activities broader than would be permissible for traditional BHCs that have not elected to be treated as FHCs, such as the Company. "Financial activities" is broadly defined to include not only banking, insurance, and securities activities, but also merchant banking and additional activities that the FRB, in consultation with the Secretary of the Treasury, determines to be financial in nature, incidental to such financial activities, or complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally.

In order to elect to become an FHC, a BHC must meet certain tests and file an election form with the FRB. To qualify, all of a BHC’s subsidiary banks must be well-capitalized and well-managed, as measured by regulatory guidelines. In addition, to engage in the new activities, each of the BHC’s banks must have been rated "satisfactory" or better in its most recent federal Community Reinvestment Act evaluation.

A BHC that elects to be treated as an FHC may face significant consequences if its banks fail to maintain the required capital and management ratings, including entering into an agreement with the FRB which imposes limitations on its operations and may even require divestitures. Such possible ramifications may limit the ability of a bank subsidiary to significantly expand or acquire less than well-capitalized and well-managed institutions. The Company has not elected to become an FHC.

Further, the GLBA permits state banks, to the extent permitted under state law, to engage in certain new activities which are permissible for subsidiaries of an FHC. Further, the GLBA expressly preserves the ability of state banks to retain all existing subsidiaries. In order to form a financial subsidiary, a state bank must be well-capitalized, and such banks would be subject to certain capital deduction, risk management, and affiliate transaction rules. Also, the FDIC’s final rules governing the establishment of financial subsidiaries adopt the position that a state nonmember bank may only conduct through a financial subsidiary activities that a national bank could only engage in through a financial subsidiary, such as real estate development or investment, continue to be governed by the FDIC’s standard activities rules. Moreover, to mirror the FRB’s actions with respect to state member banks, the final rules provide that a state bank subsidiary that engages only in activities that the bank could engage in directly (regardless of the nature of the activities) will not be deemed to be a financial subsidiary.

Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 generally authorizes BHCs to acquire banks located in any state, possibly subject to certain state-imposed age and deposit concentration limits, and also generally authorizes interstate mergers and to a lesser extent, interstate banking.

Declaration of Dividends. According to its Policy Statement on Cash Dividends Not Fully Covered by Earnings (the "FRB Dividend Policy"), the FRB considers adequate capital to be critical to the health of individual banking organizations and to the safety and stability of the banking system. Of course, one of the major components of the capital adequacy of a bank or a BHC is the strength of its earnings and the extent to which its earnings are retained and added to capital or paid to shareholders in the form of cash dividends. Accordingly, the FRB Dividend Policy suggests that banks and BHCs generally should not maintain their existing rate of cash dividends on common stock unless the organization’s net income available to common shareholders over the past year has been sufficient to fully fund the dividends and the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality, and overall financial condition. The FRB Dividend Policy reiterates the FRB’s belief that a BHC should not maintain a level of cash dividends to its shareholders that places undue pressure on the capital of bank subsidiaries, or that can be funded only through additional borrowings or other arrangements that may undermine the BHC’s ability to serve as a source of strength.

Under Maine law, a corporation’s board of directors may declare, and the corporation may pay, dividends on its outstanding shares in cash or other property, generally out of the corporation’s unreserved and unrestricted earned surplus, or out of the unreserved and unrestricted net earnings of the current fiscal year and the next proceeding fiscal year taken as a single period, except under certain circumstances, including when the corporation is insolvent or when the payment of the dividend would render the corporation insolvent or when the declaration would be contrary to the corporation’s charter. These same limitations generally apply to investor-owned, Maine financial institutions.

Federal bank regulatory agencies also have authority to prohibit banking institutions from paying dividends if those agencies determine that, based on the financial condition of the bank, such payment would constitute an unsafe or unsound practice.

Capital Requirements

FRB Guidelines. The FRB has adopted capital adequacy guidelines pursuant to which it assesses the adequacy of capital in examining and supervising a BHC and in analyzing applications to it under the BHC Act. The FRB’s capital adequacy guidelines apply on a consolidated basis to BHCs with consolidated assets of $150 million or more; thus, these guidelines apply to the Company on a consolidated basis.

The FRB’s capital adequacy guidelines generally require BHCs to maintain total capital equal to 8% of total risk-adjusted assets and off-balance sheet items, with at least one-half of that amount consisting of Tier 1 or core capital and the remaining amount consisting of Tier 2 or supplementary capital. Tier 1 capital for BHCs generally consists of the sum of common stockholders’ equity and perpetual preferred stock (subject in the case of the latter to limitations on the kind and amount of such stocks which may be included as Tier 1 capital), less goodwill and other non-qualifying intangible assets. Tier 2 capital generally consists of hybrid capital instruments; perpetual preferred stock, which is not eligible to be included as Tier 1 capital; term subordinated debt and intermediate-term preferred stock; and, subject to limitations, general allowances for loan losses. Assets are adjusted under the risk-based guidelines to take into account different risk characteristics.

In addition to the risk-based capital requirements, the FRB requires BHCs to maintain a minimum leverage capital ratio of Tier 1 capital (defined by reference to the risk-based capital guidelines) to total assets of 3.0%. Total assets for this purpose do not include goodwill and any other intangible assets and investments that the FRB determines should be deducted from Tier 1 capital. The FRB has announced that the 3.0% leverage ratio requirement is the minimum for the strong BHCs without any supervisory, financial or operational weaknesses or deficiencies or those which are not experiencing or anticipating significant growth. All other BHCs are required to maintain a minimum leverage ratio of at least 4.0%. BHCs with supervisory, financial, operational, or managerial weaknesses, as well as BHCs that are anticipating or experiencing significant growth, are expected to maintain capital ratios well above the minimum levels.

At December 31, 2001, and at the time of this report, the Company’s risk-based capital ratio and leverage ratio currently were in excess of regulatory requirements, and its management expects these ratios to remain, in excess of regulatory requirements. Separate, but substantially similar, capital requirements under FDIC regulations apply to the Company’s bank subsidiary, and these also exceed regulatory requirements.

Failure to meet capital guidelines could subject the Company or the Bank to a variety of FDIC corrective actions, including for example, (i) restricting payment of capital distributions and management fees, (ii) requiring that the appropriate federal banking agency monitor the condition of the institution and its efforts to restore its capital, (iii) requiring submission of a capital restoration plan, (iv) restricting the growth of the institution’s assets, and (v) requiring prior approval of certain expansion proposals.

Information concerning the Company and its subsidiaries with respect to capital requirements is incorporated by reference from the section entitled "Capital Resources" and from Note 13, "Shareholders’ Equity," of the notes to consolidated financial statements, each in this annual report on Form 10-K for the year ended December 31, 2001.

Activities and Investments of Insured State-Chartered Banks. FDIC insured, state-chartered banks, such as the Bank, are also subject to similar restrictions on their business and activities. Section 24 of FDIA, generally limits the activities as principal and equity investments of FDIC-insured, state-chartered banks to those activities that are permissible to national banks. In 1999, the FDIC substantially revised its regulations implementing Section 24 of the FDIA to ease the ability of state-chartered banks to engage in certain activities not permissible for national banks, and to expedite FDIC review of bank applications and notices to engage in such activities.

Other Regulatory Requirements

Customer Information Security. The FDIC and other bank regulatory agencies have published final guidelines establishing standards for safeguarding nonpublic personal information about customers that implement provisions of the GLBA (the "Guidelines"). Among other things, the Guidelines require each financial institution, under the supervision and ongoing oversight of its Board of Directors or an appropriate committee thereof, to develop, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, to protect against any anticipated threats or hazards to the security or integrity of such information, and to protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer.

Privacy. The FDIC and other regulatory agencies have published final privacy rules pursuant to provisions of the GLBA ("Privacy Rules"). The Privacy Rules, which govern the treatment of nonpublic personal information about consumers by financial institutions, require a financial institution to provide notice to customers (and other consumers in some circumstances) about its privacy policies and practices, describe the conditions under which a financial institution may disclose nonpublic personal information to nonaffiliated third parties, and provide a method for consumers to prevent a financial institution from disclosing that information to most nonaffiliated third parties by "opting-out" of that disclosure, subject to certain exceptions.

USA Patriot Act. The USA Patriot Act of 2001 (the "Patriot Act"), designed to deny terrorists and other the ability to obtain access to the United States financial system, has significant implications for depository institutions, broker-dealers, and other businesses involved in the transfer of money. The Patriot Act requires financial institutions to implement additional policies and procedures with respect to money laundering, suspicious activities, currency transaction reporting and due diligence on customers. Implementation of the Patriot Act’s requirements will occur in stages, as rules regarding its provisions are finalized by government agencies.

Deposit Insurance. The FDIA does not require the FDIC to charge all banks deposit insurance premiums when the ratio of deposit insurance reserves to insured deposits is maintained above specified levels. However, as a result of general economic conditions and recent bank failures, it is possible that the ratio of deposit insurance reserves to insured deposits could fall below the minimum ratio that FDIA requires, which would result in the FDIC setting deposit insurance assessment rates sufficient to increase deposit insurance reserves to the required ratio. A resumption of assessments of deposit insurance premiums charged to well-capitalized institutions, such as the Company’s subsidiary bank, could have an effect on the Company’s net earnings. The Company cannot predict whether the FDIC will be required to increase deposit insurance assessments above their current levels.

MANAGEMENT AND EMPLOYEES

On September 5, 2001, the Company’s Board of Directors announced its decision to recruit a President and Chief Executive Officer for the Company to bring focus to strategic management at the holding company level. Dean S. Read, who formerly served as Chief Executive officer of both the Company and the Bank, will remain as Chief Executive Officer of the Bank and will focus on management of that entity.

On February 28, 2002, the Company’s Board of Directors announced the appointment of Joseph M. Murphy as President and Chief Executive Officer of Bar Harbor Bankshares. On March 19, 2002, Mr. Murphy was appointed President and Chief Executive Officer of BTI Financial Group. Mr. Murphy will be working with the holding company and subsidiary boards of directors to set and oversee the strategic direction of the Company and its two subsidiaries, Bar Harbor Banking and Trust Company and BTI Financial Group. Mr. Murphy has 36 years of financial services experience, most recently as Executive Vice President of the Retail Banking Group for WSFS Financial Corporation. He also served in an executive capacity for Center Financial Corporation.

Dean S. Read continues to serve as President and Chief Executive Officer of the Bank. In April 2000, he succeeded Sheldon F. Goldthwait who served in that capacity for six years. Mr. Read has 32 years of banking experience, most recently as Senior Vice President and Senior Relationship Manager with Key Bank N. A. in Augusta, Maine.

In June 2001, the Company’s Board of Directors announced the appointment of Gerald Shencavitz, as Chief Financial Officer and Treasurer of the Company and each of its subsidiaries, as well as Chief Operating Officer of the Bank. Mr. Shencavitz joined the Company in April of 1998 and served as Senior Vice President of Operations and Information Systems. He brings 26 years of financial services experience in finance and accounting, audit and risk management, operations, and information systems management to the Company.

Other senior operating positions in the Company include presidents of the BTI subsidiaries, and senior Bank officers in charge of lending, retail banking, credit administration and human resources.

At December 31, 2001, the Company had 210 employees. On a full time equivalent basis, total employees at December 31, 2001, were 164.

STOCK DIVIDEND

On December 8, 1998, the Board of Directors of the Company declared a 100% stock dividend to owners of record as of December 28, 1998, payable on January 25, 1999. All share and per share data information included in the Form 10-K has been restated to reflect the 100% stock dividend.

FORWARD LOOKING STATEMENTS DISCLAIMER

The foregoing discussion, as well as certain other statement contained in this Form 10-K, or incorporated herein by reference, contain statements which may be considered to be forward-looking within the meaning of the Private Securities Litigation and Reform Act of 1995 (the "PSLRA"). You can identify these forward-looking statements by the use of words like "strategy," "expects," "plans," "believes," "will," "estimates," "intends," "projects," "goals," "targets," and other words of similar meaning. You can also identify them by the fact that they do not relate strictly to historical or current facts. For these statements, the Company claims the protection of the safe harbor for forward-looking statements provided by the PSLRA. Forward looking statements include, but are not limited to, those made in connection with estimates with respect to the future results of operation, financial condition, and business of the Company and its subsidiaries which are subject to change based on the impact of various factors that could cause actual results to differ materially from those estimated. Those factors include but are not limited to: changes in general, economic and market conditions; the development of an interest rate environment that adversely affects the interest rate spread or other income anticipated from the operation and investments of the financial services group and/or the Bank; significant changes in the economic scenario from that anticipated which could materially change credit quality trends and the ability to generate loans; significant delay in or inability to execute strategic initiative designed to grow revenues and/or control expenses; and significant changes in accounting, tax, or regulatory practices or requirements. The Company disclaims any obligation to publicly update or revise any forward-looking statement contained in the foregoing discussion, or elsewhere in this Form 10-K.

FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS

The information set forth under this item is incorporated by cross-reference to the Company financial statements set forth in Item 8 of this report.

ITEM 2. PROPERTIES

The twelve parcels of real estate owned and utilized by the Company for its operations are described below:

1. The principal office of the Bank is located at 82 Main Street, Bar Harbor, Maine, and includes a building housing banking facilities and administrative offices and an adjacent 35-car customer parking lot. The building was renovated in 1998.

2. An office is located on Main Street, Northeast Harbor, Maine. This property consists of a building constructed in 1974 that underwent interior renovations in 1998 to better meet the Bank’s needs at that location.

3. An office is located on Main Street, Southwest Harbor, Maine. This property consists of a building constructed in 1975 that was added to and renovated in 1989 to better meet the needs at that location.

4. An office is located on Church Street, Deer Isle, Maine. This property consists of a building constructed in 1974 that was added to and renovated in 1994 to better meet the needs at that location.

5. An office is located on Main Street, Blue Hill, Maine. This property consists of a building constructed in 1960 that was renovated in 1989 to better meet the needs at that location.

6. An office is located on Main Street, Milbridge, Maine. This property consists of a building constructed in 1974 to which a vestibule was added in 1994 to house an ATM that helps to better meet the needs at that location.

7. An office is located on Washington Street, Lubec, Maine. This property consists of a building constructed in 1990 and is adequate for the Bank’s needs at that location.

8. An office is located on High Street, Ellsworth, Maine. This property consists of a building constructed in 1982. The Bank is currently evaluating expansion of the Ellsworth office.

9. An office is located on Main Street, Winter Harbor, Maine. This property consists of a building constructed in 1995 and is adequate for the Bank’s needs at that location.

10. An office is located on Main Street, Machias, Maine. This property consists of a building that was purchased from Key Bank of Maine in May 1990 that was renovated in 1995 to better meet the Bank’s needs at that location.

11. An Operations Center is located on Avery Lane, Ellsworth, Maine, that houses the Bank’s operations, check clearing, technology, training, and mail departments. The building was constructed in 1996, with occupancy by the Bank taking place in January of 1997.

12. BTI owns and occupies a recently renovated 22,000-square-foot office building at 135 High Street, Ellsworth, Maine. Trust, Block, Dirigo, and the Bank occupy portions of this facility.

A parcel of land adjacent to the Blue Hill branch was purchased in 1981 but has not been developed. The Company also leases office space for Dirigo, Block, and Trust at One Cumberland Place in Bangor, Maine. Other real estates include two out parcels, one improved, contiguous to the BTI Ellsworth location.

The Bank has twelve Automated Teller Machines (ATMs) located at ten of its branch officers, plus three located on Mount Desert Island, the primary market area it serves.

ITEM 3. LEGAL PROCEEDINGS

Two former executive employees of BTI, one of whom also was a director of the Company, resigned their positions in January of 2002 and have since made monetary demands for severance benefits under their employment agreements. One of the former employees has initiated an arbitration proceeding under the terms of her employment agreement seeking a determination of her alleged right to severance payments. BTI disputes that either employee is entitled to the benefits that they have demanded. Both employees also have threatened other legal action against the Company and BTI, but the Company has not received notice that any legal proceedings have been formally instituted in connection with these matters.

The Company also is party to certain other ordinary routine litigation incidental to the normal conduct of its business, which in the opinion of management will have no material effect on the Company’s consolidated financial statements.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

As of March 1, 2002, there were 1,088 registered holders of record of Bar Harbor Bankshares common stock.

Dividends paid by the Company in 2001 and 2000:

The following table sets forth selected financial data for the last five years (Dollars in thousands, except per share data):

The purpose of this discussion is to focus on significant changes in the financial condition and results of operations of the Company and its subsidiaries during the past three years. The discussion and analysis is intended to supplement and highlight information contained in the accompanying consolidated financial statements and the selected financial data presented elsewhere in this report. Certain amounts in the 2000 financial statements have been reclassified to conform with the presentation used in 2001 and prior years.

Unless otherwise noted, all dollars are expressed in thousands except per share data.

SUMMARY

Net income for Bar Harbor Bankshares for the year ended December 31, 2001, was $3.5 million, representing $1.06 diluted earnings per share of common stock. This compares with $4.8 million, or $1.43 diluted earnings per share in 2000.

During the year 2001:

• The Bank expensed a provision for possible loan losses totaling $2.0 million, representing an increase of $1.05 million, or $693 thousand after taxes, compared with 2000. The increase in the provision was primarily attributed to one large credit that was charged off in the second quarter, together with the ongoing maintenance of the allowance for possible loan losses at a level that, in management’s judgment, is adequate to cover the amount of risk inherent in the loan portfolio and provide for probable losses.
• BTI Financial Group recorded a net after tax loss of $1.02 million for 2001, representing an increase in net loss of $626 thousand compared with 2000. Included in BTI’s 2001 net loss is an after tax restructuring charge of $408 thousand recorded in the fourth quarter, primarily as a result of management changes. The earnings performance at BTI was also impacted by continued startup expenses and declining stock and bond markets.
• The Company’s net interest income before the provision for possible loan losses amounted to $18.1 million, representing an increase of $424 thousand, or 2.4%, over that recorded in 2000. The marked decrease in interest rates in 2001 contributed to a decrease in interest income of $1.44 million while funding costs decreased $1.87 million. These dynamics were a driving factor underlying the improvement in the Company’s net interest margin from 4.02% in 2000 to 4.15% in 2001.
• Non-interest income amounted to $7.52 million compared with $7.07 million earned in the prior year, representing an increase of $454 thousand, or 6.4%. The improvement in non-interest income is principally attributed to fee enhancements implemented by the Bank in late 2000, management of customer charges, and increased revenue from BTI Financial Group.
• Excluding the one-time restructuring charge at BTI Financial Group, the Company’s non-interest expense for the year amounted to $17.87 million representing an increase of $1.25 million over 2000, or 7.6%. This increase was principally attributed to staff additions in customer service, operational and credit administration areas, and continued expansion of the BTI network.
• The Bank’s loan growth continued in 2001 and total loans ended the year at $298 million, representing a $26.6 million increase over 2000, or 9.8%. The growth in total loans was almost entirely attributable to consumer real estate and home equity loans, with these categories posting an increase of $27.3 million, or 19.0%. Commercial loans grew by $2.1 million, or 1.9%, while all other loan categories declined $2.8 million.
• At December 31, 2001, total investment securities including Federal funds sold and money market accounts were $142 million, representing a decrease of $12.4 million compared with the prior year-end. The average 2001 balance declined $16.0 million from the prior year, or 9.5%. The 2001 interest rate environment prompted accelerated pay-downs on mortgage-backed securities and the exercise of callable features on other securities, and this runoff was not immediately replaced. The overall yield on the portfolio in 2001 was 6.25% compared with 6.73% in 2000. The decrease in the securities portfolio, combined with the declining interest rate environment, account for a $1.8 million decrease in 2001 interest and dividend income from investment securities compared with the prior year.
• The Bank reduced non-performing loans to significantly lower levels than in prior years. At December 31, 2001, total non-performing loans amounted to $2.3 million, or 0.79% of total loans, compared with $8.1 million, or 2.99%, at the prior year-end. The 2001 decrease in non-performing loans amounted to $5.8 million, or 71.1%, primarily due to payouts, charge-offs, and consumer loans brought current. At December 31, 2001, non-performing loans as a percent of total loans stood at its lowest level in the past five years.
• The Company’s capital grew 4% to $52.5 million, after the payment of $2.49 million in stockholder dividends and stock repurchases of $773 thousand. Total 2001 dividends per share were $0.76, the same amount paid in the prior year. The Company continues to exceed regulatory guidelines for "well capitalized" institutions. At December 31, 2001, Tier I leverage, Tier I risk based and total risk based capital ratios stood at 10.3%, 15.6%, and 16.8%, respectively.

In managing its asset portfolios, the Bank utilizes funding and capital resources within well-defined credit, investment, interest rate and liquidity risk guidelines. Loans and investment securities are the Bank’s primary earning assets with additional capacity invested in money market instruments. Average earning assets were 93.3%, 93.4% and 94.5% of total average assets during 2001, 2000 and 1999, respectively.

The Bank, through its management of liabilities, attempts to provide stable and flexible sources of funding within established liquidity and interest rate risk guidelines. This is accomplished through core deposit products offered within the markets served, as well as through the prudent use of borrowed funds.

Average earning assets were $437,015 during 2001, representing a slight decrease of $3,290, or 0.75%, compared with 2000. In 2001 the yield on total average earning assets was 7.76% compared with 8.02% and 7.89% in 2000 and 1999, respectively. Despite eleven rate decreases resulting in a historical 475 basis point drop in the federal funds targeted rate during 2001, the Company’s yield on average earning assets held relatively stable, posting a decrease of 26 basis points compared with 2000 and 13 basis points compared with 1999.

Total 2001 interest on earning assets amounted to $33,892, compared with $35,333 and $31,952 in 2000 and 1999, respectively. Total 2001 interest on earning assets was $1,441, or 4.1%, less than that received in 2000, but $1,940, or 6.1%, greater compared with 1999.

Total loans at December 31, 2001 amounted to $297,970 as compared with $271,381 at December 31, 2000, representing an increase of $26,589, or 9.8%. The increase in total loans from 2000 is primarily attributable to consumer real estate loans, which grew $21,498 or 16.8%, and ended the year at $149,559. Home equity loans were the second largest contributor to 2001 loan growth, posting an increase of $5,831 or 37.8% over the December 31, 2000 total of $15,407.

Construction and development loans amounted to $20,348 at December 31, 2001 compared with $12,297 at December 31, 2000, representing an increase of $8,051, or 65.5%. Construction and development loans represent 6.8% of the portfolio at December 31, 2001. The increase in 2001 balances is almost entirely attributable to consumer construction loans and reflects the strong loan demand experienced by the Bank, particularly during the second half of 2001.

Mortgage loans, including consumer and commercial, account for 77.1% of total loans. At December 31, 2001 mortgage loans amounted to $229,634, compared with $208,815 at December 31, 2000, representing an increase of $20,819, or 10.0%. The increase in mortgage loans is almost entirely attributable to strong consumer mortgage loan demand driven by refinancings, combined with a robust demand for real estate in the Bank’s primary market area, Hancock County. Commercial mortgage loans, on a net basis, remained relatively flat between the periods. During 2001, three large commercial mortgage loans approximating $4,600 paid out. These decreases were compensated for with net new commercial mortgage loan growth of $5,290.

Loans to finance agricultural production and other loans to farmers amounted to $7,149 at December 31, 2001 compared with $6,674 at December 31, 2000, representing a moderate increase of $475. This category of loans represents 2.4% of the portfolio at December 31, 2001 and includes certain aquaculture loans.

Commercial and industrial loans represent 7.4% of the year-end loan portfolio. Commercial and industrial loans totaled $22,158 at December 31, 2001 compared with $23,729 at December 31, 2000, representing a decrease of $1,571, or 6.6%. The decrease in commercial and industrial loans is principally attributed to certain loan payoffs that were not replaced with new loan growth. A continued tightening of credit standards combined with enhanced pricing strategies generally reduced the amount of unsecured or partially secured loans in this category of the portfolio.

All other loans represent 1.2% of the portfolio. The balance of all other loans at December 31, 2001 totaled $3,699 compared with $3,978 at December 31, 2000, representing a decrease of $279, or 7%.

Loan interest income summary: In 2001 the total average yield on loans amounted to 8.57%, compared with 8.83% and 8.76% in 2000 and 1999 respectively. Despite the historical 475 basis point drop in the Federal Funds targeted rate during 2001, the Bank’s yield on average loan balances posted a decrease of only 26 basis points compared with 2000 and 19 basis points compared with 1999. The principal reason for the Bank’s stable loan yields in a declining rate environment results from the preponderance of fixed rate loans in the portfolio which approximate 50%, combined with enhanced loan pricing strategies adopted over the past two years.

Total interest income from loans amounted to $24,308 in 2001, compared with $23,939 in 2000, representing an increase of $369, or 1.5%. Loan volume contributed $1,023 to this increase, while the decrease in interest rates offset this amount by $654.

INVESTMENT SECURITIES

The investment securities portfolio primarily consists of United States Government agency securities, obligations of state and political subdivisions, corporate bonds, and mortgage backed securities. The overall objective of the Bank’s investment strategy for this portfolio is to maintain an appropriate level of liquidity, diversify earning assets, manage interest rate risk, and generate acceptable levels of net interest income. The investment securities portfolio is managed under the policy guidelines established by the Bank’s Board of Directors.

On January 1, 2001, the Bank, as allowed under Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 137 and SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities," repositioned a significant part of the investment portfolio from held to maturity to available for sale.

Total investment securities: Investment securities, excluding Fed funds sold and money market funds, totaled $133,609 at December 31, 2001, compared with $154,150 at December 31, 2000. This represents a decrease of $20,541, or 13.3%. The 2001 average investment securities balance amounted to $141,757, compared with $168,611 in 2000. This represents a decrease of $26,854, or 15.9%.

The decline in 2001 investment balances can be attributed to the 2001 interest rate environment, which prompted accelerated pay-downs on mortgage-backed securities and the exercise of callable features on other securities, the resulting portfolio run-off from which was not immediately replaced. In addition, investment securities that matured in 2001 were not immediately replaced. The cash flows from the 2001 investment portfolio run-off were utilized to pay down borrowings and fund loan growth. During the fourth quarter of 2001, the Bank refreshed its investment strategy and began rebuilding the investment securities portfolio balances. This activity continues into the first quarter of 2002.

The overall yield of the investment securities portfolio in 2001 was 6.43%, compared with 6.73% in 2000, representing a decline of 30 basis points. The decrease in yield is principally attributed to the exercise of callable features on the higher yielding investments and, to a lesser extent, investment purchases transacted in a rapidly declining interest rate environment.

Securities available for sale: This portfolio is managed on a total return basis with the objective of exceeding the return that would be experienced if investing solely in U.S. Treasury instruments. This category of investments is used for liquidity purposes while simultaneously producing earnings. The designation of "available for sale" is made at the time of purchase, based upon management’s intent to hold the securities for an indefinite time; however, these securities would be available for sale in response to changes in market interest rates, related changes in the securities’ prepayment risk, needs for liquidity, or changes in the availability of and yield on alternative investments.

Investment securities classified as available for sale are reported at their fair value with unrealized gains or losses, net of taxes, excluded from earnings but shown separately as a component of shareholders’ equity.

The increase in securities available for sale balances between periods is almost entirely attributed to a transfer of securities totaling $113,856 from held to maturity to available for sale in January 2001, offset by securities that either matured, paid down, or were "called" throughout 2001.

Securities held to maturity: This portfolio is managed for yield and earnings generation, liquidity through cash flow, and interest rate risk characteristics within the framework of the entire balance sheet.

Investment securities held to maturity are reported at their aggregate amortized cost. Securities held to maturity totaled $26,866 at December 31, 2001 as compared with $116,306 at December 31, 2000, representing a decrease of $89,440, or 76.9%. Securities held to maturity represent 20.1% of the portfolio as of December 31, 2001, compared with 75.4%% at December 31, 2000. At December 31, 2001 and 2000, investments held to maturity had net unrealized losses of $1,923 and $61 respectively.

The decrease in securities held to maturity balances between periods is attributed to a transfer of securities totaling $113,856 from held to maturity to available for sale in January 2001, offset by the addition of approximately $25,000 of bank qualified municipal bond purchases in the fourth quarter of 2001 that were classified as held to maturity.

Other securities: Other securities consist of money market funds, overnight Federal funds sold, and other non-marketable securities. The 2001 average balance of other securities amounted to $11,530, compared with $694 in 2000, representing an increase of $10,836. The 2001 increase was principally attributed to temporary investment of excess liquidity resulting from accelerated investment portfolio run-off and, to a lesser extent, the pre-funding needs related to investment transactions in the fourth quarter. At December 31, 2001, other securities totaled $8,464. The yield on other securities amounted to 4.09% in 2001, compared with 5.76% in 2000.

Held to maturity securities are included based upon the final maturity date of the security. At December 31, 2001, the held to maturity securities portfolio had weighted average expected life of 12.46 years, a modified duration of 10.15 years and was yielding an average of 5.47% on a non-tax equivalent basis.

Available for sale securities are included based upon the final maturity date of the security. At December 31, 2001, the available for sale securities portfolio had an average expected life of 3.97 years, a modified duration of 2.97 years and was yielding an average of 6.51%.

The Bank does not hold any securities for a single issuer, other than U. S. Government agencies, where the aggregate book value of the securities exceed 10% of the Bank’s shareholders’ equity.

FUNDING SOURCES

The Bank utilizes various traditional sources of funding to support its earning asset portfolios. Average total funding in 2001 amounted to $409,959, compared with $419,316 in 2000, representing a decrease of $9,357, or 2.23%.

Deposits: Average 2001 balances of deposits, including non-interest bearing, NOW, savings and time deposits, amounted to $279,923, compared with $280,613 in 2000. This represents a decrease of $690, or 0.25%. The decline in 2001 average deposit balances was led by non-interest bearing accounts, which decreased $1,519, or 3.44%, compared with 2000, offset by increases in interest bearing accounts, particularly money market accounts.

Management attributes the drop in 2001 average deposits, in part, to pricing strategies implemented in late 2000. The absence of 2001 deposit growth was somewhat mitigated by revenue from service charges on deposit accounts, which increased $500 or 36.6% compared with 2000, and the improvement in the Company’s net interest margin from 4.02% in 2000 to 4.15% in 2001.

At December 31, 2001, total deposits amounted to $291,833, compared with $278,076 at December 2000, representing an increase of $13,757, or 4.9%. This increase was led by savings accounts, which ended the year at $91,140 compared with $73,776 at December 31, 2000, representing an increase of $17,364, or 23.5%. The growth in savings accounts is entirely attributed to money market accounts, which are classified with savings. The growth in money market accounts was partially offset by a $11,838 decline in time accounts, presumably because of depositors’ unwillingness to commit to longer-term fixed rate investments at historically low rates.

The increase in December 31, 2001, total deposits as compared with the 2001 average balance is principally attributed to the absence of growth experienced during the first half of 2001. Pricing strategies implemented in late 2000 caused portfolio run off, particularly with respect to non-relationship accounts with premium rates.

Time deposits in denominations of $100 thousand and greater totaled $13,905 at December 31, 2001, compared with $20,294 at the prior year-end, representing a decrease of $6,389, or 31.5%. The Bank had no brokered deposits during 2001 and 2000.

Borrowed Funds: Borrowed funds consist of repurchase agreements and borrowings from the Federal Home Loan Bank (FHLB). Borrowed funds are principally utilized to support the Bank’s investment securities portfolio and, to a lesser extent, fund loan growth. Borrowed funds also provide a means to help manage balance sheet interest rate risk.

Average 2001 borrowed funds balances amounted to $130,036, compared with $138,703 in 2000, representing a decrease of $8,667, or 6.2%. At December 31, 2001, borrowed funds totaled $136,059, compared with $131,318 at the prior year-end, representing an increase of $4,741, or 3.6%.

The decline in 2001 average borrowed funds balances primarily resulted from the decline in 2001 investment securities balances. Accelerated cash flows from the Bank’s investment securities portfolio were utilized to pay down advances from the FHLB and provided funding for loan growth. The $4,741 increase in 2001 year-end balances over 2000 resulted from investment security transactions in the fourth quarter of 2001 that were partially funded with borrowings.

As of December 31, 2001, total short-term borrowings, including repurchase agreements, were $46,159 as compared with $86,318 at December 31, 2000, representing a decrease of $40,159, or 46.5%. Short-term borrowings from the FHLB decreased from $74,152 at December 31, 2000 to $31,000 at December 31, 2001, representing a decrease of $43,152, or 58.2%. Conversely, average long term advances from the FHLB increased from $24,040 during 2000 to $83,936 in 2001, representing an increase of $59,896, or 249%. At December 31, 2001, long-term FHLB advances stood at $89,900, compared with $45,000 at December 31, 2000, representing an increase of $44,900, or 99.8%.

During 2001, scheduled maturities of short-term FHLB advances were replaced with long-term advances in response to historically low interest rates and the addition and/or replacement of approximately $40,000 of long-term fixed rate assets to the balance sheet. This restructuring was accomplished while maintaining the Bank’s interest rate profile within established asset and liability policies and guidelines.

At December 31, 2001 the Company had available $22,411 in unused lines of credit from the FHLB.

Interest Expense Summary: Total interest expense was $15,751 in 2001, representing a decrease of $1,865, or 10.6% as compared with 2000. The decrease in interest rates contributed $2,935 to the decrease, while increased levels of interest-bearing liabilities offset this amount by $1,070. The cost of interest-bearing liabilities was 4.29% in 2001, compared with 4.70% in 2000, representing a decrease of 41 basis points.

SUMMARY OF DEPOSIT PORTFOLIO

CAPITAL RESOURCES

Consistent with its long-term goal of operating a sound and profitable organization, Bar Harbor Bankshares continues to be a "well capitalized" company according to regulatory standards. In 2001, the Company continued to maintain a strong capital position, which is vital in promoting depositor and investor confidence and providing a solid foundation for future growth. Historically, most of the Company’s capital requirements have been provided through retained earnings and this continues to be the case.

On December 8, 1998, the board of directors of the Company declared a 100% stock dividend to owners of record as of December 28, 1998, payable on January 25, 1999. All share and per share data included in the Form 10-K have been restated to reflect the 100% stock dividend.

In November 1999, Bar Harbor Bankshares announced a stock buyback plan. The board of directors of the Company has authorized the open market purchases of up to 10% of the Company’s outstanding shares of common stock, or 344,000 shares, with the program continuing through December 31, 2002. As of December 31, 2001, the Company had repurchased 186,314 shares of stock under this plan, at a total cost of $2,993 and an average price of $16.06. The Company holds the repurchased shares as treasury stock.

The Company has historically paid regular quarterly cash dividends on its common stock. In the third quarter of 1999, the Company increased its quarterly dividend from $0.17 per share to $0.19 per share. Quarterly dividends have continued at this rate through 2001. Each quarter the board of directors declares the payment of regular quarterly cash dividends, subject to adjustment from time to time, based on the Company’s earnings outlook and other relevant factors.

The Company’s principal source of funds to pay cash dividends and support its commitments is derived from its banking subsidiary, Bar Harbor Banking and Trust Company. As discussed herein above under "Supervision and Regulation," the Bank’s principal regulatory agency, the FDIC, limits Bank dividends to current earnings excluding securities gains while maintaining a Tier 1 leverage capital ratio of 8%, without prior approval. The Bank is in full compliance with these requirements and does not anticipate any impact on its ability to pay future dividends at historical levels.

During 2001, the Company’s shareholders’ equity grew $2,031, or 4%, to $52,538, after the payment of $2,490 in shareholder dividends, stock repurchases of $773, and including $1,783, net of tax, in value through market appreciation of the securities available for sale portfolio.

As depicted in Note 13 to the financial statements, the Bank’s capital ratios exceed all regulatory requirements for a "well capitalized" bank.

Except as may be noted in "Supervision and Regulation" herein above or "Regulatory Matters" herein below, there are no known trends, events or uncertainties nor any recommendations by any regulatory authority that are reasonably likely to have a material effect on the Company’s liquidity, capital resources, or operating results.

RESULTS OF OPERATIONS

Interest rates declined sharply throughout 2001, directly influenced by a 475 basis point drop in the Federal funds targeted rate. The declining interest rate environment resulted in a 26 basis point decrease in the Company’s yield on earning assets to 7.76%. Likewise, the Company’s cost of interest bearing funds also dropped, but at a faster rate than earning assets, posting a decrease of 41 basis points to 4.29%. These dynamics, together with refreshed loan and deposit pricing strategies implemented by the Company, were a driving factor underlying the increase in 2001 net interest income, and the improvement of the Company’s 2001 net interest margin from 4.02% in 2000 to 4.15% in 2001.

In addition to net interest income, non-interest income is a significant source of revenue for Bar Harbor Bankshares and an important factor in the Company’s results of operations. Likewise, non-interest expense represents a significant category of expense for the Company, second only to interest expense.

Total non-interest income amounted to $7,520 in 2001 compared with $7,066 in 2000, representing an increase of $454, or 6.4%. Total non-interest expense amounted to $18,489 in 2001 compared with $16,615 in 2000, representing an increase of $1,874, or 11.3%.

Non-interest income: Non-interest income from Community Banking represents 55% of Bar Harbor Bankshares’ total 2001 non-interest income. In 2001, the Bank’s total non-interest income amounted to $4,214, compared with $5,768 in 2000, representing a decrease of $1,554, or 26.9%.

Non-interest expense: Non-interest expense from Community Banking represents 72% of Bar Harbor Bankshares’ total 2001 non-interest expense. In 2001, the Bank’s total non-interest expense amounted to $13,344, compared with $12,652 in 2000, representing an increase of $692, or 5.5%.

Salaries and employee benefit expenses account for $496, or 3.9%, of the total increase in 2001 non-interest expenses. This increase was principally attributed to staff additions in customer service, credit administration, and operational areas of the Bank. Also contributing to the 2001 increase in non-interest expense was increased software depreciation of $157, primarily due to the conversion of all core applications to a new and improved integrated platform during 2000 and the implementation of on-line, real-time internet banking applications in early 2001. Other areas showing moderate increases are training and staff development, marketing and occupancy expenses.

Non-interest income: Non-interest income from financial services represents 45% of Bar Harbor Bankshares’ total 2001 net interest income. In 2001, total non-interest income at BTI Financial Group (BTI) amounted to $3,407, compared with $3,243 in 2000, representing an increase of $164 or 5.1%. Included in 2001 non-interest income is an adjustment of $322 representing a full accrual of fee income. Excluding this adjustment, total 2001 non-interest income decreased $158 or 4.9% compared with 2000.

The decline in 2001 non-interest income is principally attributed to a significant decline in the market value of assets under management at Block Capital Management (Block) and Bar Harbor Trust Services (BHTS). Fees charged to clients are derived principally from the market values of assets managed. At December 31, 2001, assets under management totaled $239,000 compared with $305,000 at December 31, 2000, representing a decrease of $66,000, or 21.6%. This decrease is principally attributed to the significant declines in the stock and bond markets throughout the year. Excluding the one-time accounting adjustment, 2001 non-interest income at Block and BHTS declined $260.

Partially offsetting the decline in 2001 revenue at Block and BHTS were increases in fee income generated by BTI’s brokerage subsidiary, Dirigo Investments. Total 2001 non-interest income at Dirigo amounted to $734, compared with $589 in 2000, representing an increase of $145, or 25%. The expansion of Dirigo’s market area via the opening of an office in Bangor, Maine, the addition of professional brokerage staff, and the transfer of certain client accounts from Block and BHTS, were the driving factors underlying the increase in Dirigo’s 2001 non-interest income.

Included in 2001 non-interest expense is a restructuring charge of $618 recorded in the fourth quarter, primarily as a result of management changes within BTI. Excluding the restructuring charge, 2001 non-interest expense amounted to $4,361, representing an increase of $504 compared with 2000, or 13.1%.

The increase in 2001 non-interest expense is principally attributed to salaries and employee benefits expense, which increased $425 or 26.5% compared with 2000. In 2001, BTI expanded its market and added staff to its offices in Bangor, Maine. Staff was also added in connection with the expansion of products and services, such as financial planning and insurance. The increase in professional staff is expected to have a positive impact on future revenues.

Occupancy expenses also showed a significant increase in 2001, primarily as a result of the purchase and renovation of BTI’s new headquarters complex in Ellsworth, Maine. Total 2001 occupancy expense amounted to $302, compared with $132 in 2000, representing an increase of $170, or 128%. Increased marketing expenses associated with the start up and expansion of the BTI network also contributed to the increase in total 2001 non-interest expense.

RATE/VOLUME ANALYSIS

The following tables represent a summary of the 2001 and 2000 changes in interest earned and interest paid as a result of changes in rates and changes in volumes.

For each category of earning assets and interest bearing liabilities, information is provided with respect to changes attributable to change in rate (change in rate multiplied by prior year volume) and change in volume (change in volume multiplied by prior year rate). The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationships of the absolute dollar amounts of the change in each.

RISK MANAGEMENT

Credit Risk

As a result of management’s ongoing review of the loan portfolio, loans are placed on non-accrual status, either due to the delinquent status of principal and/or interest, or a judgment by management that, although payments of principal and/or interest are current, such action is prudent because collection is in doubt. Loans are generally placed on non-accrual status when principal and/or interest is 90 days overdue. Consumer loans are generally charged off when principal and/or interest payments are 120 days overdue.

At December 31, 2001, loans accounted for on a non-accrual basis amounted to $2,191, or 0.74% of total loans, compared with $6,907, or 2.54%, at the prior year-end. The 2001 decrease in non-accrual loans amounted to $4,716, or 68.3%.

At December 31, 2001, total non-performing loans amounted to $2,342, or 0.79% of total loans, compared with $8,113, or 2.99%, at the prior year-end. The 2001 decrease in non-performing loans amounted to $5,771, or 71.1%. At December 31, 2001, non-performing loans as a percent of total loans stood at its lowest level over the past five years.

In 2001, the Bank established a centralized loan collection and workout department and enhanced and upgraded its collection efforts. The Bank also strengthened its credit administration function and continued tightening credit quality standards throughout the organization. The 2001 reduction in non-performing loans is principally attributed to one relationship with non-accruing aggregate outstanding loans at December 31, 2000, of $3,100, of which $1,000 was charged off and the balance repaid from asset liquidation, a $700 repayment by one particular customer, and other loans brought current, particularly consumer loans.

The allowance is maintained at a level that is, in management’s judgment, appropriate for the amount of risk inherent in the loan portfolio given past, present and expected conditions, and adequate to provide for probable losses that have already occurred. Reserves are established for specific loans including impaired loans, a pool of reserves based on historical charge-offs by loan types, and supplemental reserves to reflect current economic conditions, industry specific risks, and other observable data. Specific reserves for impaired loans are determined in accordance with SFAS No. 114, "Accounting by Creditors For Impairment of a Loan," as amended by SFAS No. 118, "Accounting by Creditors For Impairment of a Loan-Income Recognition and Disclosures."

The amount of loans considered to be impaired totaled $2,191 as of December 31, 2001, and $6,907 as of December 31, 2000. The related allowances for loan losses on these impaired loans were $517 and $2,200 as of December 31, 2001 and 2000, respectively.

SUMMARY OF LOAN LOSS EXPERIENCE

The 2001 increase in loan charge-offs includes one large credit exceeding $1,000 that was charged off in the second quarter. Increased installment loan charge offs in 2000 over those in 1999 are principally attributed to losses on two relationships.

No portion of the allowance is restricted to any loan or group of loans, and the entire allowance is available to absorb realized losses. The amount and timing of realized losses and future allowance allocations may vary from current estimates.

At December 31, 2001, the adequacy analysis resulted in a need for specific reserves of $2,805, general reserves of $584, impaired reserves of $517, and other reserves of $263. Specific reserves are determined by way of individual review of commercial loan relationships in excess of $250, combined with reserves calculated against total outstandings by category using the company’s historical loss experience and other observable data.

General reserves account for the risk and probable loss inherent in certain pools of industry and geographic concentration within the loan portfolio. Loan concentrations continue to reflect the Company’s business region. The loan portfolio includes $34,464 of loans to the hospitality industry, or 11.6% of total loans, compared with $31,242, or 11.4%, at December 31, 2000. There were no major changes in loan concentrations in 2001 and no significant changes to the allowance for possible loan losses were made in this particular regard.

Management reviews impaired loans to insure such loans are transferred to nonaccrual and written down when necessary. The review includes specific reviews of commercial relationships over $250. Smaller homogeneous loans are not individually reviewed, but are reserved collectively. Impaired reserves consider all consumer loans that are over 90 days past due and impaired commercial loans which are fully reserved within the specific reserves via individual review and specific allocation of potential loss for loans relationships over $250, and pool reserves for smaller impaired loans. The Bank had no troubled debt restructurings at December 31, 2001, and all of its impaired loans were considered collateral dependent and were adequately reserved. Total reserves against impaired loans were $517 at December 31, 2001.

Loan delinquency levels have remained at low levels for several consecutive months. However, existing loan documentation and/or structural weaknesses for certain loans written in prior years continue to impede collection efforts in certain cases and have impacted probable losses. These weaknesses are historical in nature and do not necessarily reflect current loan underwriting and documentation standards. The extent of these problems in the entire loan portfolio is not entirely known; however, it is known that such problems exist and, accordingly, the allowance for loan losses incorporates this knowledge.

The Bank’s allowance for loan losses declined slightly from December 31, 2000; however, the allowance at December 31, 2001, represents a higher percentage of delinquent and non-performing loans than in the preceding year. Management believes that the allowance at December 31, 2001, is appropriate for the risks inherent in the loan portfolio, and resident in the local and national economy as of that date.

Interest rate risk is the most significant market risk affecting the Company. Other types of market risk, such as foreign exchange rate risk and commodity price risk, do no arise in the normal course of the Company’s business activities.

The responsibility for balance sheet risk management oversight is the function of the Bank’s Asset/Liability Committee ("ALCO"), chaired by the chief financial officer and composed of various members of corporate senior management. ALCO meets regularly to review balance sheet structure, formulate strategy in light of current and expected economic conditions, adjust product prices as necessary, implement policy, monitor liquidity, and review performance against guidelines established to control exposure to the various types of inherent risk.

Interest rate risk can be defined as an exposure to movement in interest rates that could have an adverse impact on the Bank’s net interest income. Interest rate risk arises naturally from the imbalance in the re-pricing, maturity and/or cash flow characteristics of assets and liabilities. Management’s objectives are to measure, monitor and develop strategies in response to the interest rate risk profile inherent in the Bank’s balance sheet.

The Bank’s interest rate risk measurement and management techniques incorporate the re-pricing and cash flow attributes of balance sheet and off balance sheet instruments as they relate to current and potential changes in interest rates. The level of interest rate risk, measured in terms of the potential future effect on net interest income, is determined through the use of modeling and other techniques under multiple interest rate scenarios. Interest rate risk is evaluated in depth on a quarterly basis and reviewed by ALCO and the Board of Directors.

The Bank’s Asset Liability Management Policy, approved annually by the Board of Directors, establishes interest rate risk limits in terms of variability of net interest income under rising, flat and decreasing rate scenarios. It is the role of ALCO to evaluate the overall risk profile and to determine actions to maintain and achieve a posture consistent with policy guidelines.

The Bank utilizes an interest rate risk model widely recognized in the financial industry to monitor and measure interest rate risk. The model simulates the behavior of interest income and expense of all on and off-balance sheet instruments under different interest rate scenarios together with a dynamic future balance sheet. Interest rate risk is measured in terms of potential changes in net interest income based upon shifts in the yield curve.

The model requires that assets and liabilities be broken down into components as to fixed, variable, and adjustable interest rates as well as other homogeneous groupings, which are segregated as to maturity and type of instrument. Cash flows and maturities are then determined and, for certain assets, prepayment assumptions are estimated under different rate scenarios. Re-pricing margins are also determined for adjustable rate assets. Interest income and interest expense are then simulated under several rate conditions including:

Changes in net interest income based upon the foregoing simulations are measured against the flat interest rate scenario and actions are taken to maintain the balance sheet interest rate risk within established policy guidelines. In addition to the parallel simulation, interest rate risk is regularly measured under various non-parallel yield curve shifts, pricing, and balance sheet assumptions.

The following table summarizes the bank’s net interest income sensitivity analysis as of December 31, 2001 and 2000, utilizing a 200 basis point change in interest rates over one and two year horizons, with a 300 basis point change presented as of the current period.

The preceding sensitivity analysis does not represent a Company forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions including: the nature and timing of interest rate levels and yield curve shape, prepayments on loans and securities, deposit rates, pricing decisions on loans and deposits, reinvestment/replacement of asset and liability cashflows, and others. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change.

As market conditions vary from those assumed in the sensitivity analysis, actual results may also differ due to: prepayment/refinancing levels deviating from those assumed, the impact of interest rate change caps or floors on adjustable rate assets, the potential effect of changing debt service levels on customers with adjustable rate loans, depositor early withdrawals, and product preference changes, and other such variables. The sensitivity analysis does not reflect actions that ALCO might take in responding to or anticipating changes in interest rates.

When appropriate, ALCO may use off-balance sheet instruments such as interest rate floors, caps and swaps to hedge its interest rate risk position. A policy statement, approved by the board of directors of the Bank, governs use of these instruments. During 2001 and 2000, there were no off-balance sheet instruments in place.

Liquidity Risk

Liquidity is measured by the Company’s ability to meet short-term cash needs at a reasonable cost or minimal loss. The Company seeks to obtain favorable sources of liabilities and to maintain prudent levels of liquid assets in order to satisfy varied liquidity demands. Besides serving as a funding source for maturing obligations, liquidity provides flexibility in responding to customer initiated needs. Many factors affect the Company’s ability to meet liquidity needs, including variations in the markets served by its network of offices, its mix of assets and liabilities, reputation and credit standing in the marketplace, and general economic conditions.

The Company actively manages its liquidity position through target ratios established under it asset/liability management policy. Continual monitoring of these ratios, both historical and through forecasts under multiple rate scenarios, allows the Company to employ strategies necessary to maintain adequate liquidity.

The Company uses a basic surplus/deficit model to measure its liquidity over 30- and 90-day time horizons. The relationship between liquid assets and short-term liabilities that are vulnerable to non-replacement are routinely monitored. The Company’s policy is to maintain its liquidity position at a minimum of 5% of total assets. At December 31, 2001, liquidity, as measured by the basic surplus/deficit model, was 5.7% for the 30-day horizon. Including the Company’s unused line of credit at the Federal Home Loan Bank, basic surplus stood at 10.4%.

Off-Balance Sheet Risk

Commitments to extend credit: The Company makes contractual commitments to extend credit and extends lines of credit, which are subject to the Company’s credit approval and monitoring procedures. As more fully described in Note 17 to the financial statements, at December 31, 2001 and 2000, commitments to extend credit in the form of loans, including unused lines of credit and commitments to originate loans, amounted to $67,595 and $36,111 respectively. Increases in the unused lines of credit on home equity loans, combined with commercial lines of credit at year end, are responsible for the $31,484 increase in unused lines and commitments compared with 2000. In the opinion of management, there are no material commitments to extend credit that represent unusual risks.

Letters of credit and stand-by letters of credit: The Bank guarantees the obligations or performance of customers by issuing letters of credit and standby letters of credit to third parties. These letters of credit are sometimes issued in support of third party debt. The risk involved in issuing letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers, and they are subject to the same origination, portfolio maintenance and management procedures in effect to monitor other credit and off-balance sheet products. At December 31, 2001 and 2000, outstanding letters of credit and standby letters of credit totaled $5,059 and $3,626 respectively.

Counter-party risk: Pursuant to its asset/liability management policy, the Bank may enter into interest rate swap and floor agreements under which the Bank and the swap or floor counter-party would be obligated to exchange interest payments on notional principal amounts. For swap and floor transactions, the contract or notional amount does not represent exposure to credit loss. The Bank would be exposed to risk should the counter-party default in its responsibility to pay interest under the terms of the swap or floor agreement. The Bank controls counter-party risk through credit approvals, limits, and monitoring procedures. During 2001 and 2000, there were no interest rate swaps or floor agreements in place.

REGULATORY MATTERS

In the third quarter of 2001, the Bank entered into an agreement ("Agreement") with its principal regulators, the FDIC and the BFI.

Pursuant to that Agreement, the Bank has increased its allowance for loan losses, developed a classified asset reduction plan for certain commercial relationships, revised its credit administration plan, implemented certain revisions in its asset appraisal procedures, established a minimum capital threshold of 8% or 3% above the regulatory minimum of 5% for "well capitalized" banks, improved certain account reconciliation procedures, addressed certain weaknesses in its information systems, improved its procedures to ensure its compliance with the "Bank Secrecy Act," and initiated a long term strategic planning process which is currently underway. The Bank has also implemented a policy of paying dividends to its parent, the Company, only from current earnings, exclusive of gains on the sale of securities, without prior approval of its principal regulators.

The Bank is providing updates covering the status of the foregoing items to its principal regulators on a quarterly basis. In management’s judgment, the Bank is adequately addressing the matters set forth in the Agreement.

Recently Issued Accounting Standards

The Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets," requires that goodwill reflected on the Company’s balance sheet be no longer amortized to earnings, but instead be reviewed for impairment. The amortization of goodwill ceases upon adoption of the statement. The Company will adopt SFAS No. 142 effective January 1, 2002.

At December 31, 2001, the Company had $750 of goodwill stated under "other assets" on its balance sheet, related to the acquisition of Dirigo Investments, Inc., in January 2000. In connection with the preparation of the 2001 financial statements, management has evaluated the impact of adopting SFAS No. 142 and considered the potential effects of timing, application, and results of the new goodwill impairment testing methodology.

While the Company has determined that goodwill is fairly stated at December 31, 2001, it has not determined the impact, if any, of adopting SFAS No.142 on January 1, 2002.

ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The Board of Directors
Bar Harbor Bankshares

We have audited the accompanying consolidated balance sheets of Bar Harbor Bankshares and Subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with U. S. generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

/s/ BERRY, DUNN, McNEIL & PARKER

Portland, Maine
February 22, 2002